Macro Theme:

Key dates ahead:

Founder’s Note:

Futures are up 20 bps after yesterday’s wild swings. ISM is at 10AM.

Resistance: 6,950 & 6,980

Support: 6,890, 6,860

TLDR: <6,950 we remain very wary of long stock positions. >6,950 implies a test of 7k. 7k remains a place where both 0DTE and non-0DTE call sellers have stepped up, suggesting short term resistance is likely to remain.

Heading into yesterday we had been primarily discussing the instability/vol spasms, in this market which was being bred by the dispersion between single stocks (+ ETF’s) and equity vol. While markets have been spasming, its often big intraday volatility swings, which ultimately see close to close volatility muted (i.e. down 1.5% intraday and close to close is only down 0.25%). In other words the spasms led to a market that was bending, not breaking.

Turn to yesterday, wherein we showed that the level of intraday vol vs close-to-close vol was indeed anomalous, but that the forward returns from such dynamics were surprisingly positive. The S&P proceeded to puke from 6,895, punch through the Risk Pivot at 6,950, then drop to 6,860. Ultimately SPX rebounded back into 6,920.

So – did that backtest showing positive forward +3 day returns steer us wrong?

The blame yesterday was on software stocks – which have been crashing for over a week now. IGV is -25% YTD – not its jumpy realized vol spike in the plot below. Further, if you look at Compass you see nearly all of the software in that top left quadrant, which speaks to extremely high IV & expensive puts. Said another way: owning puts in these things is a very crowded trade. The other thing that catches our eye is that bottom left “bulled up” quadrant…its empty! About a week ago it was packed with Mag names, and this tied to correlation moving into extreme lows (i.e. COR1M <8).

Single stock vols are still quite elevated relative to index vols, but the over-bulled condition has evaporated. Given this, we can make the argument that things look a bit healthier in the volatility space vs a week ago. Further, despite the winging, highly correlated software selloff, SPY IV is still very sleepy which suggests minimal macro implications from dead software. Plus, as we know, in this derivatives-ladened market things tend to move violently to over-stretched extremes.

Cutting to the chase: There remains a decent vol premium with respect to +17 VIX vs 1-month SPX IV at ~10%. The fact that SPX ATM IV is at ~13% with VIX at 17 also implies some hedging is in place. You can make a case for single stock vols to come down and/or normalize with some vol premium coming out of the S&P index side (i.e. VIX ->14’s is reasonable). It does seem like the 7k level is going to put up a fight.

Seeing both sides, you can make the case that the correlation unwind is just getting started, and we need to see SPX IV jack up to 20% in order to sync with these higher single stock IVs. As an example, a look at our beloved COR1M (S&P correlation) indicator shows us that correlation could easily spike from these levels. Correlation spikes sync with VIX/vol spikes.

Given this, we want to express upside with SPY/SPX calls spreads as the IV is fairly low. We choose calls as ultimately we have to side with bears while the SPX is <6,950. This market clearly has a soft underbelly, and the ultimate risk here is that one of these spasms suddenly does not mean revert, and we see a quick 3-5% of downside. We will also dive into looking at selling put spreads or put flies in some of these software names, as the short term downside rate-of-change hits extremes (huge put skew & high IV ranks).

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